Bloomberg News

Mortgage Bond Sales Jumping 45% Hurt Fed’s Buying Efforts

By Jody Shenn
December 03, 2012

Issuance of U.S. government-backed
mortgage securities soared 45 percent last month to the highest
since at least 2009 as lenders rushed to create bonds before
guarantors Fannie Mae and Freddie Mac increase their fees.

About $207 billion of securities backed by the taxpayer-
supported firms or U.S.-owned Ginnie Mae were issued, according
to data compiled by Bloomberg. This year’s sales reached $1.6
trillion, up from $1.2 trillion in all of 2011, as refinancing
jumps amid record-low loan rates and expanded qualification
programs for borrowers with little or no home equity.

Lenders moved up issuance to precede a 10-basis-point
increase in Fannie Mae and Freddie Mac guarantee fees that took
effect Dec. 1. Sales of the securities will slow, according to
Barclays Plc analysts, after the deluge contributed to a
widening of yields on the bonds the Federal Reserve is buying
that almost erased the effect of its latest purchase program.

“This dynamic should begin to reverse now since only the
timing of issuance is affected and not the overall amount,” the
New York-based analysts led by Nicholas Strand wrote in a Nov.
30 report. December “issuance should be significantly less in
comparison. This is a significant positive.”

The difference in yields between 30-year Fannie Mae
securities trading closest to face value and the average of
those for five- and 10-year Treasuries reached 110 basis points
on Nov. 14. That was 4 basis points narrower than the gap on
Sept. 12, a day before the Fed said it would buy $40 billion
more mortgage bonds a month to bolster the economy. A basis
point is 0.01 percentage point.

Mortgage Spreads

The spread, which shrank to an all-time low of 55 basis
points on Sept. 25 after the central bank added to a
reinvestment program in which it buys about $30 billion of
securities a month, was at 103 basis points as of 12:17 p.m. in
New York, according to data compiled by Bloomberg.

Mortgage-bond analysts at Bank of America Corp (BAC:US)., who
recommended on Nov. 15 that investors bet on tighter spreads
after a widening caused by temporary factors including the
elevated issuance, recommended bondholders remain “overweight”
in their 2013 outlook published Nov. 30, as did Morgan Stanley
analysts who made that their top investment theme for next year.

While the spread has been on a “wild ride,” the central
bank’s buying “is still in its early stages and the Fed has to
entice private-market participants” to shed about $370 billion
of bonds next year, the Morgan Stanley analysts led by Vipul Jain and Janaki Rao said in their Nov. 30 report.

Bond Issuance

Gross issuance will probably total $1.67 trillion this year
and $1.75 trillion next year assuming interest rates don’t
change, according to Bank of America analysts led by Satish Mansukhani and Chris Flanagan. If borrowing costs fall 50 basis
points, issuance will rise to $2.06 trillion, the highest since
2003, the analysts said. It will total $1.47 trillion if rates
climb 50 basis points, they said.

With most sales caused by refinancing and consumers
deleveraging, the $5.2 trillion market for so-called agency
mortgage bonds will likely expand by only $15 billion this year
and contract by $70 billion in 2013, Bank of America said.

Morgan Stanley forecasted gross issuance of $1.58 trillion,
as banks restrain the total by retaining new loans to increase
their interest income, and net issuance of about $33 billion.

‘Credit Risk’

Fannie Mae and Freddie Mac have almost doubled what they
charge to guarantee bonds this year.

“These increases will move enterprise pricing closer to
what it would be were mortgage credit risk borne solely by
private capital, and could begin to incentivize private firms to
increase their participation in the mortgage market,” Edward J. DeMarco, the acting head of their overseer, the Federal Housing
Finance Agency, said in Nov. 28 speech. “We intend to stay on
that path with future increases.”

The impact of a 10-basis-point fee rise in April on the
timing of issuance was smaller, according to the Barclays
analysts, who recommended investors stay “neutral” for now.
The rush is seen in the amount of bonds created before the
monthly date in which sellers must start to inform buyers which
securities they will get under futures contracts, which is when
issuance typically spikes, they said. That will be Dec. 10.

To contact the reporter on this story:
Jody Shenn in New York at
jshenn@bloomberg.net

To contact the editor responsible for this story:
Alan Goldstein at
agoldstein5@bloomberg.net